The Electronic Revolution

Are e-cigarettes the spoils of another gold rush or a harbinger of transformation for the tobacco category?

“The rechargeable product has been our dollar driver and is starting to mature,” Sloan says.

Selling Is Believing

Whether early to the segment or a recent entrant, whether carrying one brand or five, retailers overwhelmingly are starting to believe in the segment’s potential.

“The margins are pretty good,” says Strickland. “[And] interestingly, we have not seen a fall-off on our cigarette sales, and we continue to grow electronic sales. I don’t think we’ve reached that point yet where one segment is going to cannibalize the other.”

Besides profit-friendly margins, the segment is clearly far from a plateau. Strickland started carrying electronic cigarettes only in the first quarter of this year but is already seeing results. “It’s one of the few items we sell that’s having consistent double-digit growth,” he says.

The same goes for retailers who jumped in early. Alon has been carrying four brands for nearly two years, with Slattery reporting that “sales have not slowed down one bit; these products continue to do great for us.”

With Nielsen just beginning to report on sales of electronic cigarettes, it’s been a challenge for retailers to establish what exactly constitutes the “great” numbers described by Slattery. Pittsburgh-based Management Science Associates Inc. estimates the national average of distributor-supplied products to be 11 electronic-cigarette-equivalent units (i.e., a mix of 11 disposable units or cartomizers) per week, though given the rapid growth of the segment, that figure is constantly in flux.

The dollar-sales data is even more promising: Herzog reports up to $600 million in annual brick-and-mortar e-cigarette sales, with c-store dollar sales growing 156.3% in the period concluding Sept. 28, driven by 95.5% unit growth and a 31.3% increase in the selling price. (The average price per cartomizer was $6.28 vs. $4.79 a year earlier.)

FDA on the Way

It’s true that electronic cigarettes have been growing by double digits since they burst onto the retail scene, and they’ve prompted comparisons to energy drinks. But remember: Energy drinks never faced strict regulations from the FDA that could limit marketing and innovation.

One of the most striking advantages e-cigarettes have enjoyed over their cigarette brethren is the complete lack of regulations in the subcategory. Unlike other tobacco products, electronic cigarettes can be advertised virtually anywhere—NJOY ran TV ads during the Super Bowl and Oscars—and do not need FDA approval to bring a new product to the market.

For now, that is. With an announcement on deeming regulations having been expected in October and several federal and state legislators proposing e-cig excise taxes, plenty of challenges are pending. Can the segment thrive in a regulated, taxed and consolidated world?

While it’s generally agreed that electronic cigarettes will be regulated in some way, no one is certain whether the agency will impose the same strict restrictions currently on tobacco cigarettes or acknowledge the products’ potential health benefits. (See sidebar on p. 55 for potential regulations.)

Herzog believes it’s likely that the FDA will limit or ban online sales and enact tighter restrictions as a way of preventing youth access. All of these measures “could slow growth trajectory a bit, but then it will continue,” she says.

Clearly, an online ban and minimum purchase age are supported by the c-store channel, because most retailers already practice age verification and would benefit greatly if electronic cigarettes could be sold only by brick-and-mortar retailers.

It’s a different story if the FDA decides to limit youth access by forcing electronic cigarettes to be merchandised behind the sales counter. While some retailers—including Slattery—believe this move is inevitable and have thus incorporated electronic cigarettes into the backbar, others believe this could create harsh obstacles.

“We’ve seen a particular retailer [do this], and this change caused total sales to drop by nearly 50%,” says Greg Doyle, CEO of Metro brand parent Nicotek LLC, Wheat Ridge, Colo. “This product line is too raw to hide. We have consumers to educate, and we will not be successful in continuing this rapid growth by hiding the product.”

Another critical question is whether consumers will turn away should e-cigs be hit with the excise taxes that affect most of the current tobacco set. Put bluntly, could taxation kill this exciting new segment?

The federal government has not yet passed a tax on electronic cigarettes, but Strickland and others see it as just a matter of time. Minnesota became the first state to enact an e-cig tax, applying the 95% tobacco products tax to the wholesale cost of disposable units. So now, if a product wholesales at $5.90, a tax of $5.60 is applied, resulting in a cost of $11.50—which brings the suggested retail price of a single disposable e-cigarette to $16.89.

“It’s been a challenge for us operationally,” says Sloan, who has stores in Minnesota. “This influences the way we can set pricing, it makes things much more complicated and it’s definitely hurt our sales.”

And if sales begin to dwindle, how long will it be before retailers are forced to sacrifice their margins in order to grow the category?

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